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In this video version of the investing report, StocksInValue analyst David Walker interviewed Clime Chief Investment Officer John Abernethy about this week’s RBA rate cut, plunging bond yields and the ASX company reporting season now underway. The key points were:

  • After the strong July a volatile August lies ahead.
  • The RBA rate cut indicates the broader economy is growing too slowly and the central bank is concerned about the level of the A$.
  • Some stocks are highly priced and need extraordinary results to justify them.
  • Our model portfolio will move into better value stocks in the mid-market, which has run hard but has further to go. Most ASX 20 stocks have problems.
  • Our recent successful calls on CCP, NCK and QUB are adding to our returns.
  • A problem for Australia is our attractive yields, which attract foreign capital and push our currency higher, thus dampening our soft economy. To combat this the RBA is caught up in the zero-sum central bank currency wars where rate cuts are intended to engineer currency depreciations, support inflation and net exports.
  • There is now the possibility of quantitative easing in Australia. One idea would be to buy foreigners out of our bond market because in any financial crisis foreign debt is a strong risk.
  • The RBA rate cut is the latest crunch to retirees funding their living expenses with term deposits. The current cycle is going to mean taking a long term view on investing where capital drawdowns could be necessary for a couple of years to meet expenses. At some point interest rates will rise again.

DW: What does this weeks’ events mean to ASX investors?
JA: Well, it’s probably a precursor to a lot of volatility in August. We know that with results season it was a very strong July. Probably to some extent pre-empting a reasonably strong results season – it’s probably gone a little bit too far. The interest rate cuts yesterday, I think, indicates that the broader economy is just in a slow grind growth cycle. The Reserve Bank is clearly concerned about the Australian dollar and it flagged that. I think also that the Reserve Bank is very active in a covert fashion dealing with the banks. The remarkable thing about yesterday was the instantaneous interest rate adjustments by the big 4 banks, both on the lending rates (mortgages) and term-deposits (1-year). You don’t get that synchronisation without direction. So the central bank is very active. They’re active because they must have concerns about the economy, and the Australian dollar.
DW: So, the market’s just had its’ best July in 6 years. Should people be selling? Buying in anticipation of a new trend higher? Or ignore short-term volatility because long-term value is going to be present?
JA: There’s going to be good news and there’s going to be tough news. I mean, we all saw Credit Corps result yesterday, which has been a good one for us. Obviously it was a good result, re-pricing, justifying our valuation. But there are other stocks, which are very highly priced and they actually need extraordinarily good results to justify those prices. Not saying they won’t get them. I wrote about them in ‘The View’ last week. There’s 5 or 6 stocks, I could’ve written about another half dozen, who are very highly priced based on expectations that are going to be very hard to meet. It doesn’t mean anything. It just means that the market is pricing some stocks very highly.
We’d rather see our portfolios move into better value stocks. I would say there is an issue at the top end of the market. I think it’s been well flagged and I think a lot of asset managers are suggesting that the top end of the Australian market is going to be in trouble. The interest rate cut yesterday suggested to us that banks are going through a lower margin cycle as well as other issues they have. So that puts a real dampener on the index. We know the big resource companies are in trouble with the commodity prices coming down. We know the Telco’s and the retailers are fighting for market share. We know builders are probably at the top of their cycle. You’ve got a big part of the market. So we’re suggesting that you will probably be moving money from the top end of the market to middle market, but you’ve got to pay a fair price. You can’t just buy anything at a ridiculous multiple.
DW: So, we’ve done well out of Credit Corp, Nick Scali and Qube, amongst others. Are these stocks still buyers, or more holds now?
JA: Oh, well they’re very good holds. I mean they’ve all got earnings momentum in them. Qube are longer term. Brilliant positioning there, I think, in terms of that acquisition yesterday in the inland port at Moorebank. That’s an outstanding long-term play. Nick Scali’s just a very good retailer in a very strong niche. And Credit Corp, I think their expansion into the US will pay off in the next couple of years and I think it’s been a very good strategy to invest and take a longer term view. Another stock that has come into mind is IMF, which we’ve come back into. It’s got an American strategy rolling out which makes it pretty good as well.
So you can pick the eyes out of the middle market. I know its run hard. That’s where the performance has been for the last year or so. But I think there’s more to go there. And I think this reporting season, the next four weeks, it will be good to meet management of some of these companies and see whether they can sustain it.
DW: Sure. Now with the currency, it appears the Reserve Bank rate cut did no better than hold the currency where it is. Perhaps, stopped it going further. We saw predictions at 77, 78 cents if they didn’t cut. We are getting sucked into the global central bank currency wars, where does all this end?
JA: There’s an interesting article in the Financial Review this morning, which is reiterating something I said a year ago. In the next 6 months, the way things are going, we could see quantitative easing in Australia. I think the AFR editor put his finger on it. The big issue for Australia is that the interest rate cycle in Europe and Japan can’t continue.
The bond markets have run too hard. I think bond managers want to escape because they’re looking at a negative return at some point in the next year or two, serious negative returns. The escape mechanism is anywhere you can get a yield. Australia presents as a yield market. We don’t want to cut yields so far that destroy our own returns, but we’re encouraging short-term capital here. So, one argument is that a quantitate easing program comes in and the Central Bank buys foreign investors out of our bond market. Now that gives them a free profit and gets rid of them.
We’re not talking crisis, but the last thing you want in an economic crisis is a large amount of foreign debt and foreign creditors, because they will just run and the cost of debt will fly up. Based on this, the RBA may be forced to execute a QE program.
In terms of forecasting the Aussie dollar, I think we will hold around the 76 level as a top 76 – 76.5. The trade account was very poor yesterday, and surprisingly poor. Issues like that will push down the Aussie dollar. The problem is that interest rates work one way and logic works the other. Eventually logic will work our way and the currency will fall.
DW: Just one final question on interest rates. Whether they keep falling through RBA cash rates or quantitative easing, they continue to crunch down further and further on the ability of self-funded retirees to fund their living expenses through traditional term deposits. Where do these people go? There is no simple alternative. The large cap stocks, which have yield, are unattractive as you’ve said. What do people do to generate income?
JA: You’ve got to take a long-term view of investing. Short term chasing of higher returns or yields will lead you into higher risk assets. So, accept that we’ve got a couple of years where maybe your income won’t match your pension drawdown. Just accept that.
DW: So you’re drawing down on capital?
JA: Yes, that’s a possibility. Don’t panic by it. Also, expect that a normal cycle will reoccur at some point and then you’ll get interest rates going up again, which will cover your pension. If you panic and take high-risk assets on board, yes you’ll get a short-term yield kick, but you might burn capital at twice the rate of not panicking. So, don’t be panicked into chasing big yields.
DW: So, beware promises of big returns at this time when people might be really desperate. Ok, thank you John and thank you very much for watching. As always, please leave any comments below on how you liked this video format for The View. If you have any questions about the macro side of investing – the economy, the currency, market themes, these are the things that John covers in the view each week.
Thanks for watching and see you next time.